It has been over two and half years since the Securities and Exchange Commission (SEC) staff last released its “Dear CFO Letters,” which provide non-authoritative, yet helpful and transparent commentary directed toward chief financial officers. Their guidance generally relates to specific accounting and financial reporting matters facing registered investment companies (RICs), business development companies (BDCs), registered investment advisers and their independent public accountants.
These staff positions are intended to be read in conjunction with other staff views related to accounting matters published on the SEC’s website. The staff encourage stakeholders to engage directly with them on any questions raised by the changes or if they believe the positions merit reevaluation.
The following summarizes three recently released staff “Dear CFO Letters”:
1. 2023-01 — Financial Highlights Requirements for Registered Closed-End Funds and BDCs
(Issued Nov. 29, 2023)
- For registered closed-end funds, i.e., interval or tender offer funds, and BDCs, there is currently a difference in presentation of financial highlights as required by Form N-2 in the fund’s financial statements versus its prospectus.
- Financial statements — Five most recent years of financial highlights are required to be presented with at least the most recent year audited.
- Prospectus — The last 10 fiscal years (or the registrant’s life and its immediate predecessors, if less), but only for periods subsequent to the registrant’s first registration statement. The latest five fiscal years must be audited.
- When registered closed-end funds and BDCs file Form N-2 and incorporate by reference documents subsequently filed, which include reports on Form 10-K or N-CSR containing the fund’s financial statements, they must comply with the presentation and audit requirements of both the financial statements and prospectus.
- Therefore, the financial highlights presented within the financial statements on Form 10-K, for a BDC, or Form N-CSR, for a registered closed-end fund, should meet the financial highlights requirements of the prospectus as detailed above.
- If financial highlights from the last 10 fiscal years (or life, if less) are not presented in the financial statements, the registrant may file a prospectus supplement.
2. 2023-02 — Rule 6-11 and Supplemental Financial Information in Connection with an Acquisition
(Issued Nov. 29, 2023)
- Regulation S-X Rule 6-11 currently requires RICs and BDCs to provide certain supplementary financial information in connection with a fund acquisition. This includes:
- The fund’s current fees in a table, along with the acquired fund and pro forma fees if different post-acquisition.
- A modified schedule of investments of the acquired fund if the acquisition results in a material change in the acquired fund’s portfolio due to investment restrictions, including narrative disclosure describing the material change.
- Narrative disclosure about any material accounting policy differences.
- If certain required supplementary information is not included, the staff encourages registrants to clearly disclose the reason and has provided examples:
- Disclose the fact if there are no material differences in accounting policies.
- Disclose the fact and provide narrative, including a statement that shows the ratio of the target fund’s securities that will be sold if the fund is repositioning as part of the acquisition but not because of investment restrictions.
- The staff cautions registrants against structuring a transaction to avoid the requirements of the rule. Determining whether or not an acquisition is probable or has occurred can be complicated. A registrant should consider whether the transaction results in the acquisition of all or substantially all of the acquired fund’s investment portfolio. They believe registrants should evaluate the economic substance of the transaction and not just its legal form to determine whether or not a transaction has occurred or is probable.
- For example, if a RIC or BDC is seeding a newly formed entity, the registrant generally should provide additional information regarding the investments to be acquired. In the staff’s view, this allows for increased transparency to potential investors. There have been instances where the staff has requested registrants to provide a Regulation S-X compliant schedule of investments that includes information on the investments to be acquired.
3. 2023-03 — Change in Accounting Principle
(Issued Nov. 29, 2023)
- The staff reminds both registrants and auditors about disclosure requirements surrounding the impact of new accounting standards that have been issued but are not yet effective.
- This disclosure guidance applies to all accounting standards not yet adopted by the registrant, unless the registrant determines the impact to the fund’s financial position and results of operations to be immaterial.
- Form N-CEN requires registrants to indicate any change in accounting principle or practice that will materially affect the fund’s financial statements. If a registrant answers yes to Item B.21 of the form, they must provide an attachment to include additional disclosure regarding the change. The fund’s independent registered accounting firm must also approve or otherwise comment on the change, known as a preferability letter. However, the issuance of a FASB Accounting Standards Update that requires an entity to change an accounting principle would not require a preferability letter to be accompanied with the registrant’s attachment to Item B.21. Auditors are reminded to continue to evaluate instances where a change in accounting principle has a material effect on the financial statements and needs to be recognized in their report.
Rescission and Modification of Prior “Dear CFO Letters”
The staff have also withdrawn their views discussed in a few historical letters, including:
- 1999-05 – Adviser Accounting for Offering Costs
- This letter expressed staff views on the capitalization of offering costs, which is now established and codified in ASC 946-720.
- 2001-01 – Audit Guide Implementation
- Views on this topic are now discussed in 2023-03 as noted above.
The staff have also modified their views discussed in certain historical letters, including:
- 1995-11 – Pro Forma Fee and Capitalization Tables
- The staff modified the position in the Accounting Matters Bibliography (Bibliography) to reflect the impact of Rule 6-11 as discussed above, and to provide views regarding pro forma fee tables and capitalization tables to be included in a registration statement where multiple potential outcomes may exist.
- 1999-08 – Transmittal of Reports and Financial Statements Submitted via SEC Edgar
- The staff modified this position in the Bibliography to discuss the rules governing the transmittal and filing of both semi-annual and annual shareholder reports. Shareholder reports must be transmitted to stockholders within 60 days after the close of the period for which such report is being made. If the 60th day falls on a weekend or holiday, shareholder reports must be transmitted prior to or on that date. Shareholder reports must be filed with the SEC no later than 10 days after transmission to stockholders. However, unlike the transmittal requirement, if the last day falls on a weekend or holiday, shareholder reports may be filed the following business day.
- 2019-01 – Auditor Verification of Securities Owned for RICs and BDCs
- The staff modified this position in the Bibliography to express their views applicable to all investment companies regarding auditor confirmation of pending trades. They believe the auditor’s responsibility for confirming the existence of securities owned by the fund also applies to pending trades. However, where a confirmation has not yet been received, these pending trades may be substantiated by other appropriate alternative procedures.
As the SEC continues to focus on increased transparency, we welcome the staff’s views on various accounting, financial reporting and auditing matters. Although not authoritative, these letters help provide additional context to CFOs, fund administrators and auditors to continue to adhere to the highest level of quality and transparency necessary to protect investors.
>> Read the SEC’s Chief Accountant of the Division of Investment Management published “Industry Comment Letter.”
>> Find the Accounting Matters Bibliography.
Contact Syed Farooq at sfarooq@cohenco.com or a member of your service team to discuss this topic further.
Cohen & Co is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.